For most Americans, Social Security plays an important role in maintaining retirement security. The benefit payments represent an income stream that is free of default, investment, inflation and longevity (outliving your money) risks.
In other words, regardless of economic and market conditions, Social Security pays an annuity that will increase with inflation and continue for as long as you or your spouse lives.
It is well known that workers and spouses who qualify for Social Security can elect to receive them at any age between 62 and 70. Benefits received before an individual reaching full retirement age, or FRA, are subject to an actuarial reduction for early retirement. Conversely, delaying benefits until age 70 would result in an increase in the benefit amount.
Less well known is the impact that continuing to work has on an individual who is already collecting Social Security. A person's decision when to collect benefits is independent of when they decide to leave the workforce. There is nothing to prevent someone who is eligible to receive benefits from doing so while remaining on the job. However, for those who claim benefits before FRA, and continue to work and exceed certain income thresholds, Social Security imposes an "offset" that reduces, sometimes substantially, the full monthly benefit that would otherwise be paid.
This offset is known as the Retirement Earnings Test, or RET, and it applies to employment income only, not earnings from investments, pensions, etc.
Under this test, a worker who will be younger than FRA during the entire calendar year will be subject to a $1 reduction in benefits for every $2 they earn above $18,240, as of 2020. This represents a $600 increase from 2019's earnings test limit of $17,640.
Once your earnings exceed $18,240, you'll have $1 in benefits withheld for every $2 you make. The money you have withheld will be added back into your benefits once you reach FRA. If you earn $20,240 in 2020 and you're 62 years old, you will sacrifice $1,000 in benefits for being $2,000 above the earnings test limit.
However, you will get it back later on.
The rules work differently if you will be reaching FRA in 2020. In this scenario, the earnings test limit is $48,600 next year, which is an increase of $1,680 from 2019's $46,920 limit. Once your earnings exceed $48,600 in 2020, $1 in benefits will be withheld for every $3 you make.
The conventional wisdom among seniors is that the RET represents a harsh penalty that, when added to payroll and income taxes, removes any financial incentive to continue working. Therefore, at a time when most seniors would greatly improve their financial security by maximizing their income, they instead choose to reduce their earnings below the test's thresholds to avoid triggering the reduction.
Worse yet, some leave the workforce entirely. This perception is based on an incorrect interpretation of the test. The misunderstanding exists, in large part, because the Social Security Administration and the financial-services industry have done a poor job of explaining how the test works.
Here are the facts: It is true that the Retirement Earnings Test reduces the benefit for Social Security recipients under full retirement age who continue to work and earn above the legal thresholds. However, once the recipient reaches full retirement age, Social Security increases the monthly benefit amount for the remainder of the person's life. Assuming the individual lives to average life expectancy, they would recoup any benefits lost due to the RET in earlier years.
So rather than a permanent penalty, the RET represents a retiming of payments from the pre-FRA years to the post-FRA years, when most seniors could benefit from the higher income.
John Spoto is the founder of Sentry Financial Planning in Andover and Danvers. For more information, call 978-475-2533 or visit www.sentryfinancialplanning.com.